NCPA - National Center for Policy Analysis

Good Advice?

March 19, 2003

The design of a company's 401(k) plan strongly influences investment decisions by participants because employees tend to follow naive diversification rules and view plan features as implicit investment advice by the firm, say researchers. As a result, employees' retirement assets may not be as diversified as they should be.

A study of 994 publicly traded companies from 1991 to 2000 -- where the average share of participants' discretionary 401(k) contributions in company stock was 19 percent -- found that companies have significantly increased the number of investment alternatives offered in recent years.

  • The number of investment alternatives offered by the plan is a significant indicator of the share of contributions employees put in company stock.
  • Allocations to company stock are substantially lower in plans that offer more alternatives.

They found another trend in employees' purchase of company stock for their 401(k):

  • Employees of firms that match contributions with company stock put more of their own contributions in company stock; conversely, employees of firms that limit the amount they can put in company stock or require that part of the match not be in company stock invest less of their own money in company stock.
  • A switch from allowing the employee to invest the match without restriction to requiring that the match be all in company stock is not offset by the employee reducing his own contributions in company stock.
  • An examination of other plan restrictions, such as minimum or maximum limits on company stock purchases, suggests that workers also take investment cues from plan restrictions.

Finally, corporations that pay dividends were much more likely to offer stock as match for employee contributions. This likely reflects the fact that the subsequent dividends paid on the stock will be considered compensation expense and thus will reduce a firm's future taxes.

Source: Les Picker, "The Purchase of Company Stock in 401(k) Plans," NBER Digest, January 2003; based on Nellie Lang and Scott Weisbenner, "Investor Behavior and the Purchase of Company Stock in 410(k) Plans: The Importance of Plan Design," Working Paper No. 9131, August 2002, National Bureau of Economic Research.

For study text (requires subscription) http://www.nber.org/papers/W9131

For free NBER Digest text http://www.nber.org/digest/jan03/w9131.html

 

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